At-A-Glance
This issue marks the start of the
second year for the Audit & Accounting
Alert. In the inaugural issue last
February, the results of the PCAOB
inspections of the Big 4 audit practices
in the United States were covered.
A year later, our first article looks
at the latest inspection reports to see
what has changed. Looking back over this
first year of publication, much coverage
has also been given to the long,
challenging road toward global financial
accounting standards. Two areas that
will play a key role in the future
effectiveness of those standards are
disclosures and professional ethics.
American and international boards are
developing frameworks for both that are
designed to provide useful roadmaps to
facilitate future efforts and actions.
Our second and third articles describe
current projects in these two endeavors.
Editor Gerald E. Herter, CPA
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In This Issue
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Audit Inspection Results in for National Firms
Deficiencies reveal ongoing need for improvement
Annual inspection reports on all Big Four
audit firms have been completed, with the final
one issued in December 2012. Judging by the
number of deficiencies noted, little ground has
been gained over the prior year. Shortcomings
were found in 23% to 41% of audits selected for
examination by the PCAOB, compared with rates of
20% to 45% in 2011.
The reports, available on the PCAOB website,
are useful for all auditors in that they provide
insights to common instances of substandard
work. As expected, numerous issues were raised
in the testing of the complex area of fair value
determinations. However, failings in basic
procedures, such as those related to
confirmations and depreciation calculations,
were also detected.
In all four reports, the inspectors indicated
that “deficiencies included failures by the Firm
to identify, or to address appropriately,
financial statement misstatements, including
failures to comply with disclosure requirements,
as well as failures by the Firm to perform, or
to perform sufficiently, certain necessary audit
procedures.” A firm’s claim to have performed a
procedure was not accepted in the absence of
actual documentation or other persuasive
evidence.
Undue reliance was placed on assumptions,
both from management and external sources.
Schedules and analyses provided by the client to
support an assumption were at times accepted
without further testing, or only by inquiry of
the client, without corroboration with
substantiating evidence. For example,
rollforward documentation produced by the client
was not sufficiently scrutinized.
In many cases, tests of internal controls
were found to be inadequate. Consequently, the
substantive test procedures were also deficient,
since they placed a level of reliance on the
internal control that was not warranted, due to
the control testing inadequacy. For example, in
testing the operating effectiveness of a control
related to revenue and costs, the completeness
and accuracy of data used in the operation of
the control were not tested. Therefore, improper
reliance was placed on that control when
designing the substantive procedures to assess
completeness, existence and valuation of revenue
and costs.
The inappropriate reliance on internal
controls and management assumptions was similar
to concerns in the prior year, as well as a lack
of understanding of valuation methods,
inadequate updates of interim to year end
results evaluation, and a lack skepticism The
PCAOB felt that the concerns over flawed
internal control audits were so significant that
a separate report was issued in December to
address just this issue. Similarly, the
recurrent failure to apply professional
skepticism led to the December PCAOB Staff Audit
Practice Alert on skepticism discussed in last
month’s issue.
On a global scale, the International Forum of
Independent Audit Regulators (IFIAR) in December
issued its first survey of audit inspection
findings. The IFIAR was founded in 2006, has a
membership of independent audit regulators from
44 jurisdictions, and focuses on 1) sharing
related knowledge and experience, 2) promoting
regulatory collaboration and consistency, and 3)
providing a platform for dialogue on audit
quality. The survey covered member inspection
reports issued in the twelve months prior to
June 30, 2012. That timing would include the US
reports from 2011.
The IFIAR survey results indicate that the
deficiencies in US audits are consistent with
those found elsewhere in the world. The most
frequent items related to fair value
measurements, internal control testing, and
engagement quality control reviews. Specifically
for major financial institution audits, the most
frequent findings related to internal control
testing, valuation of investments and
securities, and the audit of allowance for loan
losses and loan impairments.
The lack of professional skepticism was
noted, also. Furthermore, concerns with audit
firm quality control systems questioned whether
they provided “reasonable assurance that 1)
audit engagements are performed in accordance
with professional standards and legal
requirements; 2) the firms have sufficient
personnel with the technical competence,
capabilities, and commitment to ethical
principles necessary to perform audits; and 3)
the firms and its personnel are in compliance
with independence and ethical requirements.”
The survey report concluded: “The fact that
so many findings recur year after year in the
same inspection theme areas, suggests that audit
firms should take steps to develop a robust root
cause analysis to gain a clearer understanding
of the factors that underlie these findings and
take appropriate actions to remediate those
inspection findings.” Apparently, the corrective
steps that the audit firms claim to have taken
in response to their inspection reports have so
far not been effective in resolving the
shortcomings. A good next step would be for
audit firms to study the documents mentioned in
this article for new insights.
On a more positive note, the 2012
Annual Report of the United Kingdom’s Audit
Commission disclosed that its review of audits
of local governmental bodies showed that the
auditors had made improvements over the prior
year’s audits. Even so, even there room for
improvement was called for as to professional
skepticism, not sacrificing audit quality due to
fee pressure, assuring independence, better
communications to audit committees, and better
evidence supporting auditor judgments.
For further information, see
PCAOB
Inspection Reports,
IFIAR Audit Inspection Survey, and
PCAOB Report on Internal Control Audits
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Accounting Boards Address Financial Statement
Disclosures
The elusive search for optimum communication
The IASB and FASB are separately responding to the
call for more effective and practical approaches that
will determine financial statement disclosures.
Meaningful and appropriate disclosures are key
components for describing how accounting principles are
applied in financial statements. Both boards intend to
develop frameworks for disclosure to replace the rather
piecemeal and inconsistent practices currently in place.
In July, the FASB issued an Invitation to Comment
(ITC), Disclosure Framework, followed by two forums in
October. The comment period for the ITC ended November
30, and a summary of the forums was released in
December. The ITC observed that the preparation of
financial statement notes “can be an exercise in
complying with requirements instead of in communicating
useful information and only useful information.” This
state of affairs has resulted from the large volume of
required notes, questionable relevance, and a lack of
discretion in the disclosures to be included.
The ITC describes a possible framework for developing
disclosure requirements that would be relevant,
flexible, and employ user judgment for determining
applicability. As such, a note disclosure would be
required if “a) it is unique to an entity or its
industry; b) it is not already apparent from financial
statements or readily available from public sources to
which users could be expected to have access; and c) it
could make a material difference in assessments of
future cash flow prospects.”
With over 80 comment letters and more than 50
participants in the forums, there was wide support for
disclosure reform, but also a wide spectrum of opinions
as to how to get there. While excessive disclosures can
cause difficulty in locating the important issues that
lie within them, at the same time other important issues
may be missing altogether. Another concern is whether
materiality should be used instead of, or along with,
relevance as a criteria. Additionally, flexibility is
considered helpful, but may need to be tempered with the
need for structure in order to retain comparability and
consistency.
Those in the public arena were hesitant for any
recommendations to be implemented unless the SEC was
involved as well, to assure compatibility in
requirements. In this regard, there is hope that with
recent congressional action and changes in SEC
leadership, there may be a more receptive stance from
the SEC for disclosure reform.
As the Disclosure Framework process continues, the
FASB has proposed an Accounting Standards Update to
address a disclosure concern specific to private
entities. The amendment to ASU 2011-04 would exempt
private entities from the requirement to disclose fair
value hierarchy (Level 1, 2 or 3) for items that are not
measured at fair value in the statement of financial
position, but for which fair value is disclosed in the
footnotes.
The IASB initiated a “Request for Views” consultation
process in July 2011, regarding its future agenda, that
drew 243 comment letters, and included 105 meetings,
conferences and roundtables, leading to a Feedback
Statement issued in December. Financial statement
disclosure issues were incorporated in the discussion of
the Conceptual Framework project.
The IASB process in this area trails the FASB effort
by about a year. The Conceptual Framework project will
focus on the reporting entity, financial statement
presentation, elements and measurement, as well as
disclosures. Given a high priority and targeting
September 2015 for completion, the project has scheduled
a Discussion Paper for June, akin to the ITC, and will
also hold a multi-stakeholder forum in 2013. The forum
may generate some short-term fixes while the overall
project continues. The hope is that practical guidance
may result that streamlines current disclosure
requirements.
Input received by the IASB reflects concerns similar
to those heard by the FASB. The Feedback Statement
states that “Preparers have told us that they adopt a
checklist approach because it is more costly to apply
judgement: they first have to justify their decisions to
their auditor and then, sometimes publicly, with
regulators who question the absence of a particular
disclosure.” Consequently, potentially irrelevant
disclosures are included because that is more efficient
and less hassle for the preparer.
In another development, the International Public
Sector Accounting Standards Board is in the midst of
preparing the Conceptual Framework for General Purpose
Financial Reporting by Public Sector Entities. This
Framework will address the needs of users in the public
sector. Initial chapters have just been issued, with
completion of the rest expected by 2014.
For further information, see
Financial Statement Disclosure Effectiveness: Forum
Observations Summary and
Feedback Statement: Agenda Consultation
Ethics Convergence and Codification
Code of Conduct updates parallel financial standards
projects
The International Ethics Standards Board for
Accountants (IESBA) was formed as an independent body by
the International Federation of Accountants (IFAC) in
1977 to develop and maintain ethics guidelines that
members would agree to follow. IFAC has members in 129
countries, including the AICPA, that have responsibility
for audit and assurance standards in their respective
jurisdictions.
The AICPA for the past twelve years has been in the
process of converging the AICPA Code of Professional
Conduct with the IESBA Code of Ethics for Professional
Accountants. Convergence has been a consideration during
the AICPA’s four year Ethics Codification Project which
is nearing completion. (An Exposure Draft is planned for
April). Similar in concept to the accounting standards
codification project, the Ethics Codification is
designed to pull together relevant material into a
topical format that is clearer and easier to use.
The conceptual framework is part of the convergence
effort taking place within codification. According to
the AICPA, the conceptual framework “provides a system
for identifying and evaluating threats to compliance
with ethical standards (e.g., independence) and
determining whether safeguards would eliminate threats
or reduce them to an acceptable level (e.g., such that
they no longer impair independence).” The framework
comes into play where there is no specific guidance for
an ethics question that arises. In such cases, a member
is expected to apply the conceptual framework approach.
While finishing touches are put on the expected
Ethics Codification Exposure Draft, the AICPA continues
to propose ethics interpretations. A current proposal
would revise Interpretation No. 102-4, “Subordination of
Judgment by a Member” under Rule 102, Integrity and
Objectivity. (The Comment Period ended January 16). The
proposal broadens the current interpretation to include
members in public practice as well as private,
performing services for a client, employer, or as a
volunteer. Also, the scope is expanded, from
disagreements over the preparation of financial
statements or the recording of transactions, to cover
differences of opinion with a supervisor related to the
application of accounting principles, auditing
standards, or other relevant professional standards,
including standards applicable to tax and consulting
services, or applicable laws or regulations.
If a member perceives a threat from a difference of
opinion, the member should assess, using research or
consultation, whether the difference represents a
failure to comply with professional standards, and if
so, creates a material misrepresentation of fact or a
violation of applicable laws or regulations. A failure
to comply that is not material nor a violation, would
not be considered significant, but should be discussed
with the supervisor. A failure to comply that is
material or a violation would be significant, requiring
a discussion with the supervisor to resolve. If not
resolved, higher level management should be consulted,
and if still not resolved, other safeguards and
obligations should be considered, including resignation.
A member can resign at any time, but that in itself does
relieve the member of responsibility for any required
actions.
The IESBA currently has an Exposure Draft pending
with some similar elements that draws a different
conclusion. “Responding to a Suspected Illegal Act” was
proposed in August for which comments were due by
December 15, 2012. When a suspected illegal act
(including fraud) is encountered, the accountant is
required to seek appropriate resolution through
progressively higher levels of management. However, if
ultimately the response is not appropriate and the
accountant’s judgment is that disclosure would be in the
public interest, then disclosure of certain illegal acts
to an appropriate authority is required if the
accountant is providing audit services to the client. If
not the auditor, the accountant is required to disclose
the matter to the entity’s external auditor, and
possibly to appropriate authorities. Resignation may
also be appropriate, but also does not absolve the
accountant of required action.
The AICPA issued a detailed Comment Letter to the
IESBA that, among other things, disagrees with the
requirement to disclose suspected illegal acts to
external authorities unless “required of an accountant
by a national regulator, pursuant to a law or regulation
that also incorporates “safe-harbor” provisions that
protect the accountant from potential liability for
allegedly unauthorized or unjustified disclosures.”
Otherwise the accountant could be put “at risk of
violating his or her legal or contractual duties of
confidentiality to a client or employer.”
Since the Comment Period for both the IESBA and AICPA
proposals has ended, the outcome of how the differences
are handled may be forth coming in the near future.
For further information see
AICPA Ethics Codification Project,
Subordination of Judgment by a Member and
Responding to a Suspected Illegal Act
Additional A&A News
The following links provide a selection of current articles
devoted to highlighting other A&A topics currently making
news.
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AICPA committee withdraws
compilation, association ED
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Sir David Tweedie: Audit upheaval a "wonderful
opportunity"
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The Question of Mandatory Audit Firm Rotation
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SEC’s New Chief: Dodd-Frank, JOBS Act Top SEC’s
Priority List
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Integrated Reporting and Sustainability in South
Africa
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FASB Focuses on Nonpublic Companies
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